Fears of a Europe-wide financial transactions tax sent tremors through the City and other European bourses after Angela Merkel and Nicolas Sarkozy backed the idea of a new levy.

Shares in banks and other financial institutions were hardest hit in downbeat London trading amid concerns that the tax would add to the cost of doing business and drive firms overseas.

The Franco-German plan was strongly supported by campaigners for a so-called Robin Hood tax, but strongly opposed by the CBI. In a study released on Thursday, the Adam Smith Institute said any attempt to introduce such a tax into Britain would be "economic suicide".

Pointing to Sweden, where a tax of 0.5% was placed on the purchase of equity securities and stock options in 1984, the institute said that 60% of the 11 most actively traded Swedish shares migrated to London and more than 50% of Swedish equities had moved to London by 1990. The tax was subsequently dropped. Sam Bowman, head of research at the institute, described the proposed tax as vague and economically illiterate.

The Robin Hood Tax Campaign, which supports the use of the levy in Britain, has argued the financial sector should "pay their fair share to clear up the mess they helped create". It believes that a small tax could generate £20bn annually in Britain without having a negative impact on the prosperity of the financial sector.

Max Lawson, the campaign's spokesman, said: "This is a major step forward which leaves the UK increasingly isolated in insisting that a financial transaction tax must be global to work. Rather than standing on the sidelines, David Cameron should join Sarkozy and Merkel to make banks pay their fair share."

"Europe now has an historic opportunity to make the financial sector work in our interests and help millions of people here and in poor countries who have been hurt by a crisis they did nothing to cause."

In the City, the prospect of tax rate harmonisation and a new financial transaction tax pledged at the Franco-German summit did not ease fears about the stability of the region. The FTSE 100 closed 26 points lower to reach 5331.6, having dropped almost 80 points in early trading. Germany's Deutsche Börse and pan-European exchange NYSE Euronext also fell. The three exchanges would all be affected if traders were forced to pay a small fee every time they bought and sold stocks or currencies.

"One of the intended purposes of the financial transactions tax would be reduce trading volumes. This would be negative for businesses which thrive on the flow of financial transactions," stockbroker Collins Stewart said in a note.

Neil Bentley, the CBI's deputy director general, said: "To consider the introduction of a financial transaction tax at a time when we should be totally focused on promoting growth is a mistake. Such a tax could have the opposite effect, increasing the cost of capital for businesses and holding back their growth potential.

"This tax would divert transactions to other jurisdictions, like New York and Hong Kong, damaging the UK's long-term competitiveness, and it is unlikely to raise significant revenues."

Irish finance minister Michael Noonan said that any such tax should be imposed across the EU rather than just the eurozone. He also argued that the Franco-German plan to harmonise their corporation tax levels would not affect Ireland's current rate of just 12.5%. Investors continued to flock to safe havens such as the Swiss franc, which gained 2% against the euro despite the Swiss central bank pledging to take steps to lower the currency's value.